Life insurance demand under health shock risk

Holger Kraft, Lorenz S. Schendel and Mogens Steffensen

No 40, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

Abstract: This paper studies the life cycle consumption-investment-insurance problem of a family. The wage earner faces the risk of a health shock that significantly increases his probability of dying. The family can buy term life insurance with realistic features. In particular, the available contracts are long term so that decisions are sticky and can only be revised at significant costs. Furthermore, a revision is only possible as long as the insured person is healthy. A second important and realistic feature of our model is that the labor income of the wage earner is unspanned. We document that the combination of unspanned labor income and the stickiness of insurance decisions reduces the insurance demand significantly. This is because an income shock induces the need to reduce the insurance coverage, since premia become less affordable. Since such a reduction is costly and families anticipate these potential costs, they buy less protection at all ages. In particular, young families stay away from life insurance markets altogether.

Keywords: Health shocks; Portfolio choice; Term life insurance; Mortality risk; Labor income risk (search for similar items in EconPapers)
JEL-codes: D14 D91 G11 G22 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-dge, nep-hea and nep-ias
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:safewp:40

DOI: 10.2139/ssrn.2392384

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